TY  - JOUR
AU  - Devereux,Michael B.
AU  - Engel,Charles
TI  - Expenditure Switching vs. Real Exchange Rate Stabilization: Competing Objectives for Exchange Rate Policy
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 12215
PY  - 2006
Y2  - May 2006
UR  - http://www.nber.org/papers/w12215
L1  - http://www.nber.org/papers/w12215.pdf
N1  - Author contact info:
Michael B. Devereux
Department of Economics
University of British Columbia
997-1873 East Mall
Vancouver, BC V6T 1Z1
CANADA
Tel: 604/822-2542
Fax: 604/822-5915
E-Mail: mbdevereux@gmail.com

Charles Engel
Department of Economics
University of Wisconsin
1180 Observatory Drive
Madison, WI  53706-1393
Tel: 608/262-3697
Fax: 608/262-2033
E-Mail: cengel@ssc.wisc.edu
AB  - This paper develops a view of exchange rate policy as a trade-off between the desire to smooth fluctuations in real exchange rates so as to reduce distortions in consumption allocations, and the need to allow flexibility in the nominal exchange rate so as to facilitate terms of trade adjustment. We show that optimal nominal exchange rate volatility will reflect these competing objectives. The key determinants of how much the exchange rate should respond to shocks will depend on the extent and source of price stickiness, the elasticity of substitution between home and foreign goods, and the amount of home bias in production. Quantitatively, we find the optimal exchange rate volatility should be significantly less than would be inferred based solely on terms of trade considerations. Moreover, we find that the relationship between price stickiness and optimal exchange rate volatility may be non-monotonic.
ER  -